Internal Analysis (Module 2)

Concept of Value Chain

In high paced business climate, organizations are offering high quality
product to gain long term competitiveness. In order to achieve desired
results, the company has to match and then exceed their competitors, and
even discover what the customers want and satisfy their expectations.
Strategic analysis helps the company focus its plan and hence achieve a
competitive advantage. A strategic management accounting technique
used to measure the importance of the customer's perceived value is
value chain analysis. Through evaluating the strategic advantages and
disadvantages of the company's activities and value-creating processes
in the market place, value chain analysis is needed to evaluate the
company's competitive advantages.

Value chain analysis proposes the systematic view of organizations

composed of stages in transformation process with inputs and outputs to
each of the distinct stages (Satya Sekhar, 2009). Value chain analysis is
dependent on the basic fiscal principle of advantage. Companies are best
served by operating in sectors where they have a relative productive
advantage compared to their competitors. Concurrently, companies
should ask themselves where they can deliver the best value to their
customers.
Michael Porter (1995) introduced the notion of Value chain in his book
"Competitive Advantage: Creating and Sustaining Superior
Performance". The concept of value added, in the form of the value
chain, can be utilized to develop an organization’s sustainable
competitive advantage in the business field of the 21st Century. All
organizations consist of activities that link together to develop the value
of the business, and together these activities form the organization’s
value chain. Such activities may include purchasing activities,
manufacturing the products, distribution and marketing of the company's
products and activities (Lynch, 2003). The value chain framework has
been used as a powerful analysis tool for the strategic planning of an
organization for nearly two decades. The aim of the value chain
framework is to maximize value creation while minimizing costs. Porter
described as the price that customer is prepared to pay for an offering.
Profit is the difference between this value and total cost to the enterprise
providing that offering (Satya Sekhar, 2009). He outlines the value chain
as the internal processes through which the company designs, produces,
sells, delivers and supports its product. Cost is no longer treated as an
expense that goes to the profit and loss account, but it is treated as value
that accumulates to company wealth as shown in balance sheet.

Porter indicates that "a company's value chain and the way it performs
individual activities are a reflection of its history, its strategy, its
approach of implementing its strategy, and the underlying economics of
the activities themselves." From fundamental perspective, the value
chain framework is an approach for breaking down the sequence of
business functions into the strategically relevant activities through which
utility is added to products and services. Value chain analysis is
undertaken in order to understand the behavior of costs and the sources
of differentiation (Shank and Govindarajan, 1993). Porter (1980) argued
that a business can develop a supportable competitive advantage based
on cost, differentiation, or both.

Source: Shank and Govindarajan (1993)

To perform a value chain analysis, the company begins by recognizing

each part of its production process and identifying where steps can be
eliminated or improvements can be made. These improvements can
result in either cost savings or improved productive capacity. The end
result is that customers derive the most benefit from the product for the
cheapest cost, which improves the company's bottom line in the long
run.
The notion of the value chain is based on the process view of
organizations, the idea of seeing a manufacturing (or service)
organization as a system, made up of subsystems each with inputs,
transformation processes and outputs. Inputs, transformation processes,
and outputs involve the acquisition and consumption of resources -
money, labor, materials, equipment, buildings, land, administration and
management. How value chain activities are carried out determines costs
and affects profits.

The main purpose of value chain is to measure the value delivered and
profit contributed by each link of chain. A value chain is linked set of
value creating activities beginning with basic raw material coming from
suppliers, moving onto the series of value added activities involved in
producing and marketing a product or services and ending with
distributors getting the final goods into the hands of ultimate consumers
(Satya Sekhar, 2009).

Most organizations engage in numerous activities in the process of

converting inputs to outputs. These activities can be classified generally
as either primary or support activities that all businesses must undertake
in some form.

Porter (1985) grouped business activities under two categories that

include primary product line activities and support activities. Primary
activities are the processes directly involved in transforming materials
into finished goods, then goods delivery and after sales services to goods
sales. They basically include:

1.​ Materials intake, specification check, handling and warehousing

2.​ Materials and components processing into finished goods
3.​ Order processing and distribution
4.​ Communication, pricing and decision-making by management, and
5.​ Installation, repair and parts replacement.

In detail, Porter's value chain model (1985) described five value

generating primary activities (Satya Sekhar, 2009).

These primary activities are:

Inbound Logistics - involve relationships with suppliers and include all

the activities required to receive, store, and disseminate inputs. These
activities are associated with receiving, storing, disseminating inputs to
the product such as material handling, warehousing, inventory control,
vehicle scheduling and return to suppliers.

Operations: These are all the activities required to transform inputs into
outputs (products and services). For example machining, packing
assembly, equipment maintenance, testing, printing and facility
operations.
Outbound Logistics: These include all the activities required to collect,
store, and distribute the output. Such as finished goods warehousing,
material handling, delivering vehicle operation, order processing and
scheduling.

Marketing and Sales: Activities inform buyers about products and

services induce buyers to purchase them, and facilitate their purchase.
Such as Advertising, promotion, sales force quoting, channel selection,
channel relation and pricing.

Service - includes all the activities required to keep the product or

service working effectively for the buyer after it is sold and delivered.
Such as installation, repair, training, parts supply and product
adjustment.

Support activities are the processes and actions to facilitate the primary
product line activities. They are the company's staff functions.
Secondary activities of value chain are as follows:

Procurement - is the acquisition of inputs, or resources, for the firm.

Human Resource management: This consists of all activities involved in

recruiting, hiring, training, developing, compensating and (if necessary)
dismissing or laying off personnel.
Technological Development: It pertains to the equipment, hardware,
software, procedures and technical knowledge brought to bear in the
firm's transformation of inputs into outputs.

Company Infrastructure – This serves the company's needs and ties its
various parts together, it consists of functions or departments such as
accounting, legal, finance, planning, public affairs, government
relations, quality assurance and general management.

Porter's Value Chain

Value chain analysis is a practice that yields value enhancement. There

are two components of value chain analysis: the industry value chain and
the company's internal value chain. The industry value chain includes all
of the value-creating activities within the whole industry, beginning with
the basic raw material and ending with the after-sales service of the
product sold. The internal value chain of a company comprises of all the
value creating activities of that specific company.

To gather information for Value Chain Analysis, Analysts can explore

various sources to find information necessary for conducting the value
chain analysis. Up to three years of annual reports of the company can
be analyzed to see how the costing of the activities are changing over the
period and whether they are in unison with the competitive strategy of
the firm. These annual reports of the company can be compared to the
annual reports of the major competitors in order to see how competitive
strategies differ between the companies, along with finding the
difference in the contribution of activities to the company's profitability.
In order to gain knowledge about the core competence of the company,
analysts can look at the company and competitor websites. SWOT
analysis of the companies done by companies like Data monitor can help
the analyst to understand the key strengths and weaknesses of the
company and how the firm differs from its competitors. Furthermore,
journal articles, trade publications and magazines are useful sources of
information to identify how value is created in the particular industry in
which the company operates and which activities play a key role in the
generation of that value.
Implementation of Value Chain Analysis

There is a three-stage process to perform value chain analysis. It delivers

value to customers and reviews all processes to maximize product value.

1.​ Activity Analysis: Ascertain the activities that contribute to the

processing of the product or service.
2.​ Value Analysis: Identify the items and/or services that customers
value in the way one conducts each activity, and then calculate the
changes based on relevant structural and/or executioner cost drivers.
3.​ Evaluation and Planning: Decide what changes to make and determine
how to conduct the plan.

The value chain approach for assessing competitive advantage: Most

corporations describe their mission as one of creating products or
services. For these organizations, the products or services generated are
more important than any single step within their value chain. In contrast,
other companies are fully aware of the strategic importance of individual
activities within their value chain. They succeed by concentrating on the
particular activities that allow them to capture maximum value for their
customers and themselves. These firms use the value chain approach to
better understand which segments, distribution channels, price points,
product differentiation, selling propositions and value chain
configurations will yield them the greatest competitive advantage. The
way that the value chain approach supports organizations evaluate
competitive advantage is through numerous analysis:

1.​ Internal cost analysis: To determine the sources of profitability and the
relative cost positions of internal value-creating processes.
2.​ Internal differentiation analysis: To understand the sources of
differentiation (including the cost) within internal value-creating
processes.
3.​ Vertical linkage analysis: To understand the relationships and
associated costs among external suppliers and customers in order to
maximize the value delivered to customers and to minimize cost.

Basically, companies start by focusing on their internal operations and

gradually widen their focus to consider their competitive position within
their industry. The value chain approach to appraise competitive
advantage is vital part of the strategic planning process. Value chain
analysis is a continuous process of gathering, evaluating and
communicating information for business decision-making. By
stimulating strategic thinking, the analysis assists managers envision of
the company's future and implement decisions to attain competitive
advantage. Organizations adopt the value chain approach to recognize
sources of profitability and to understand the cost of their internal
processes or activities (David Barnes, 2001). The main steps of internal
cost analysis are:
1.​ Identify the firm's value-creating processes.
2.​ Determine the portion of the total cost of the product or service
attributable to each value creating process.
3.​ Identify the cost drivers for each process.
4.​ Identify the links between processes, and
5.​ Evaluate the opportunities for achieving relative cost advantage.

A firm must de-emphasize its functional structure to identify its

value-creating processes. Most of large businesses still organize
themselves as cost, revenue, profit and investment centres. These and
other organizational sub-units, such as departments, functions, divisions
or separate companies that are normally used for control purposes are
not very useful for identifying value creating processes. Adopting a
process perspective requires a horizontal view of the organization,
beginning with product inputs and ending with outputs and customers.
Organizations also adopt the tool of value chain approach to identify
opportunities for creating and sustaining superior differentiation. In this
situation, the primary focus is on the customer's perceived value of the
products and services. It can be said that firm's value chain is embedded
in large stream of activities. Suppliers have value chain that create and
deliver the purchased input used in firm's chain. Suppliers not only
deliver the product but also can influence a performance of firm in
numerous ways. Additionally, many products pass through value chains
of channels on their way to the buyer. Channels perform additional
activities that affect the buyer and influence firm's own activity. A firm
product eventually becomes part of buyer's value chain. The ultimate
basis for differentiation is firm and its product role in the buyer's value
chain which determine buyer's needs. Achieving competitive advantage
depends on to understand value chain of firm and how firm fits to its
overall value system (David Barnes, 2001).

Value Chain and Competitive Advantage (David Barnes, 2001)

Benefits of Value Chain Analysis

The value chain links up a series of value creating activities from

supplier to customer. The intent of value chain analysis is to perform
value chain activities more efficiently and at a lower cost than rivals.
The focus is the chain from the customer's viewpoint. Value chain
analysis extends from materials input, work-in-process and finished
goods manufactured to other primary activities as after-sales services, as
well as support activities as procurement, technology, human resources
management and company infrastructure. Value chain analysis is a
framework that can provide a number of benefits to the management of
online learning organizations. This analysis can support managers to
identify linkages between value activities within the organization, and to
think in terms of process rather than function or department. Through
analysis of the value system, managers can identify potentials for
strategic alliances with various actors in the industry value system.
Identification of cost drivers and linkage with value chain activities help
managers to focus on cost reduction and on finding ways to optimize
returns throughout the value chain. As well, value chain analysis helps
managers to understand cost management problems. Failure to see the
impact of a decision on the overall value chain will result in missed
opportunities.

Drawbacks of Value Chain Analysis

Value chain analysis is considered as a new strategic management

accounting device and has several operational demerits:

1.​ Availability of data: Company data about revenues, costs, and assets
used for value-chain analysis are obtained from financial information
in a single period. Multiple-period data for long-term strategic
 decision-making, changes in cost structures, capital investments and
market prices may not be immediately available.
2.​ Ascertainment of revenues, costs and assets: Identification of
appropriate revenues, costs, and assets for each value chain activity is
quite difficult. As there is no scientific approach, and most work is
done through trial-and-error and experimentation methods.
3.​ Identification of cost drivers: Isolation of cost drivers for
value-creating activities, identification of value chain linkages across
activities, and computation of supplier and customer profit margins
present major constraints.
4.​ Identification of stages: Identification of stages in an industry's value
chain is affected by the ability to locate at least one company
department that participates in a specific stage. Breaking down a value
stage into two or more stages is necessary for diagnosing abilities at
various stages.
5.​ Opposition from employees: Value chain analysis involving strategic
partners outside the company is still a new concept and is not easily
understood by all employees. It may face resistance from front line
staff as well as managers.

The use of value chain analysis facilitates the strategic management of

an organization. Michael Porter's influential work in strategic
management elucidates the fundamentals of how organizations compete.
To summarize, value chain process integrates external and internal data,
applies appropriate cost drivers for all major value-creating processes,
exploits linkages throughout the value chain and offers continuous
monitoring of a company's strategic competitive advantage. It involves
the inputs of other strategic partners, such as material suppliers, finished
goods wholesalers, and final customers. The main objective is to
conduct value chain activities more efficiently, and ultimately surpass
industrial competitors. Value chain analysis can support companies to
determine which type of competitive advantage to follow, and how to
pursue it. Many academicians stated that value chain is an effectual
technique for organizational appraisal as it helps in providing clarity
about the areas of strengths and weaknesses. It is a popular framework to
analyze and develop competitive advantage.

Swot analysis
Swot analysis involves the collection and portrayal of information about
internal and external factors which have, or may have, an impact on
business.

SWOT is a framework that allows managers to synthesize insights

obtained from an internal analysis of the company’s strengths and
weaknesses with those from an analysis of external opportunities and
threats
●​ Strengths describe what an organization excels at and
what separates it from the competition: a strong brand, loyal
customer base, a strong balance sheet, unique technology, and so
on. For example, a hedge fund may have developed a proprietary
trading strategy that returns market-beating results. It must then
decide how to use those results to attract new investors.
●​ Weaknesses stop an organization from performing at its optimum
level. They are areas where the business needs to improve to
remain competitive: a weak brand, higher-than-average turnover,
high levels of debt, an inadequate supply chain, or lack of capital.
●​ Opportunities refer to favorable external factors that could give
an organization a competitive advantage. For example, if a country
cuts tariffs, a car manufacturer can export its cars into a new
market, increasing sales and market share.
●​ Threats refer to factors that have the potential to harm an
organization. For example, a drought is a threat to a
wheat-producing company, as it may destroy or reduce the crop
yield. Other common threats include things like rising costs for
materials, increasing competition, tight labor supply and so on.
Benefits

Swot tool has 5 key benefits:

●​ Simple to do and practical to use;

●​ Clear to understand;
●​ Focuses on the key internal and external factors affecting the
company;
●​ Helps to identify future goals;
●​ Initiates further analysis.

Limitations

Although there are clear benefits of doing the analysis, many managers
and academics heavily criticize or don’t even recognize it as a serious
tool. According to many, it is a ‘low-grade’ analysis. Here are the main
flaws identified by a research: Excessive lists of strengths, weaknesses,
opportunities and threats;

●​ No prioritization of factors;
●​ Factors are described too broadly;
●​ Factors are often opinions not facts;
●​ No recognized method to distinguish between strengths and
weaknesses, opportunities and threats.
We now discuss the details of the steps of SWOT analysis involved in
the SWOT analysis.
Steps of SWOT Analysis
1st External Environmental Analysis:
External environment analysis is the first step of the steps of SWOT
analysis. From this, we have to obey the following things. Such as:-

●​ Identify the key political, economic, social-cultural, demographic,

natural/ecological and technological forces that are most likely to
affect the organization.

●​ Monitor information on the environmental forces.

●​ Select the methods to be used in forecasting these forces.

●​ Isolate the marketplace chances on the origin of the forecasts of these

forces.

●​ Estimate the inclinations in these navies.

●​ Identifying the threats to the organization’s future profitability.

2nd Industry and Competitive Analysis:

The second is the industry and competitive analysis of the steps of

SWOT analysis. There are included the following indicators. Such as:-

●​ Examine the landscape of struggle.

●​ Study the business construction.

●​ Identify and analyze individual competitors.

●​ Identify the key industry-related opportunities and threats.
3rd Identification of Opportunities and Threats:

The external analysis (one of the steps of SWOT analysis) will provide
you with information for the identification of threats and opportunities in
the external environment. It is the responsibility of the management to
ensure that information derived from environmental scanning is
summarized and analyzed to determine what characterize these threats
and threats. One method of performing an opportunity and threat
analysis is simply to categorize the environmental factors in terms of
opportunity potential and threat potential. Then management should
summarize the emerging implications for future organizational direction.
A sample opportunity and threat analysis for Comilla Foundry (producer
of tube-wells) are presented in the following table.

4th Internal Environmental Analysis and Identification Internal

Strengths & Weaknesses:
The fourth phase of the steps of SWOT analysis is it. That name is
internal environmental analysis and identification of internal strengths &
weaknesses. But it is divided into two categories. Such as:-

1.​ Internal Environmental Analysis

2.​ Identification Internal Strengths and Weaknesses
1. Internal Environmental Analysis
The internal environmental analysis is the sup-step of the steps of
SWOT analysis. We have to read these important indicators. Such as:-

●​ Recognize the areas for scrutiny (for instance product position,

financial position, etc.)

●​ Evaluate the strengths and weaknesses for their strategy-making

implications.

●​ Detecting association’s inner resource and strengths abilities.

●​ Examine each of the nominated zones.

●​ Identifying the organization’s internal weaknesses and resources

deficiencies.
2. Identification Internal Strengths and Weaknesses
It is the second sub-step of the steps of SWOT analysis. The information
derived from the internal analysis would provide you the basis for
identification of strengths and weaknesses of your organization. While
identifying the strengths and weaknesses, you need to bear in mind that
the skills and capabilities which are likely to serve as enablers for
strategy formulation and implementation are to be listed as strengths.
Those which are not enablers should be listed as the weakness. You use
the example-based format, as shown in the following table. For
identification and listing of strengths and weaknesses.
5th Concluding SWOT Analysis and Drawing Conclusion:
Concluding SWOT Analysis and Drawing Conclusion is the final one of
the steps of SWOT analysis. Under it has following things. Such as:-

●​ Assess the attractiveness of an organization’s situation on the basis of

identified strengths, weaknesses, opportunities and threats.

●​ Draw conclusion regarding the need for strategic action.

Resources, Competencies and Distinctive

Capabilities
Resources

The activities and processes of the organization utilize certain assets.

These assets are called resources. These resources can be created within
the organization. They form the internal resources. Such generated
resources are organization-specific. Otherwise they could be obtained
externally from the suppliers available in the resource markets. They
form the external resources. The externally obtained resources are
organization-addressable. In addition resources can be categorised as
specific or non-specific. Those resources which can only be used for
extremely specialized intentions and are significant to the organization
in adding value to goods and services are called specific resources.
Non-specific resources are less specific and are less significant in adding
value. Also resources can be broadly classified as tangible and
intangible. The physical assets that an organization possesses are called
tangible resources. The physical resources, human resources and final
resources come under this category.

The intellectual resources, technological resources and the

organizational reputation together form the intangible resources. The
patents and copyrights of the organization are typical examples of
intellectual resources. The innovation capacity and innovation speed are
examples of technological resources. Reputation is basically good-will
that the organization has acquired among the customers. It is a critical
resource of an organization.

Competencies

An organization should posses some characteristics in order to have the

ability to compete with other organizations in the market place. These
characteristics form the competencies of the organization. For any
organization to survive in an industry competencies are must. At the
same time competencies cannot be useful to an organization when they
stand alone. It is when they combine together in the right combination
that they help the organization to attain competitive advantage. For
instance consider an information technology organization. For this to
compete in the software industry it should posses the competencies to
write programs and design tools which have to be combined together to
provide it with the competitive advantage in the industry.

Distinctive Capabilities

An organization’s resources which are critical in imparting it with

competitive advantage are called distinctive capabilities. When the
capabilities originate from an attribute which other firms do not have
then they form an organization’s distinctive capabilities. In addition to
having a distinctive characteristic it should also be sustainable and
appropriable.

When a distinctive capability is able to continue functioning over a

period of time it is said to be sustainable. When the organization which
holds a distinctive capability is able to benefit mainly from it then it
becomes appropriable. An organization can derive the distinctive
capabilities mainly the organizational architecture, organization
reputation and innovation. The relationships between the organization
and the stakeholders are critical in developing these three aspects of the
organization.

Dynamic Capabilities

The ability to achieve new forms of competitive advantage is referred to

as dynamic capabilities. The two terms dynamic and capabilities by
itself require in depth understanding while studying competitive
advantage.

The ability to renovate competences so as to accomplish corresponding

with the transforming business environment is referred to as dynamic.

The main characteristics of being dynamic are:

▪​ It requires definite innovation is responding to situation such as the

right time to enter the market.
▪​ The timing is vital in such a case.
▪​ In addition when there are swift changes in the field of technology
and when the character of prospective competition and market is
hard to be ascertained the dynamic nature becomes vital for
sustained competitive advantage.

The important function of strategic management in fittingly modifying,

incorporating and reconstituting the internal as well as the external
organizational skills, resources, and functional competences to
correspond with the necessity of a transforming environment relates to
the term capabilities.

Thus dynamic capabilities address rapidly changing environment. They

suggest an organization's capacity to accomplish new and innovative
forms of competitive advantage.
Core Competency of organization

The core competency theory is the theory of strategy that prescribes

actions to be taken by firms to achieve competitive advantage in the
marketplace. The concept of core competency states that firms must play
to their strengths or those areas or functions in which they have
competencies. In addition, the theory also defines what forms a core
competency and this is to do with it being not easy for competitors to
imitate, it can be reused across the markets that the firm caters to and the
products it makes, and it must add value to the end user or the
consumers who get benefit from it. In other words, companies must
orient their strategies to tap into the core competencies and the core
competency is the fundamental basis for the value added by the
firm.

Core Competencies and Strategy

The term core competency was coined by the leading management

experts, CK Prahalad and Gary Hamel in an article in the famous
Harvard Business Review. By providing a basis for firms to compete and
achieve sustainable competitive advantage, Prahalad and Hamel
pioneered the concept and laid the foundation for companies to follow in
practice.
Some core competencies that firms might have include technical
superiority, its customer relationship management, and processes that are
vastly efficient. In other words, each firm has a specific area in which it
does well relative to its competitors, this area of excellence can be
reused by the firm in other markets and products, and finally, the area of
strength adds value to the consumer. The implications for real world
practice are that core competencies must be nurtured and the business
model built around them instead of focusing too much on areas where
the firm does not have competency. This is not to say that other
competencies must be neglected or ignored. Rather, the idea behind the
concept is that firms must leverage upon their core strengths and play to
their advantages.

Some Examples

If we take the examples from real world companies and evaluate their
core competencies, we find that many firms have benefited from the
application of this theory and that they have succeeded in attaining
competitive advantage and sustainable strategic advantage. For instance,
the core competencies of Walt Disney Corporation lie in its ability to
animate and design its shows, the art of storytelling that has been
perfected by the company, and the operation of its theme parks that is
done in an efficient and productive manner. Hence, Walt Disney
Corporation would be well advised to configure its strategy around these
core competencies and build a business model that complements these
competencies.

Competitive advantage

Competitive advantage means superior performance relative to other

competitors in the same industry or superior performance relative to the
industry average.

What is competitive advantage?

There is no one answer about what is competitive advantage or one way

to measure it, and for the right reason. Nearly everything can be
considered as competitive edge, e.g. higher profit margin, greater return
on assets, valuable resource such as brand reputation or unique
competence in producing jet engines. Every company must have at least
one advantage to successfully compete in the market. If a company can’t
identify one or just doesn’t possess it, competitors soon outperform it
and force the business to leave the market.

There are many ways to achieve the advantage but only two basic types
of it: cost or differentiation advantage. A company that is able to achieve
superiority in cost or differentiation is able to offer consumers the
products at lower costs or with higher degree of differentiation and most
importantly, is able to compete with its rivals.

An organization that is capable of outperforming its competitors over a

long period of time has sustainable competitive advantage.

Cost advantage. Porter argued that a company could achieve superior

performance by producing similar quality products or services but at
lower costs. In this case, company sells products at the same price as
competitors but reaps higher profit margins because of lower production
costs. The company that tries to achieve cost advantage
([Link]) is pursuing cost leadership strategy. Higher profit
margins lead to further price reductions, more investments in process
innovation and ultimately greater value for customers.

Differentiation advantage. Differentiation advantage is achieved by

offering unique products and services and charging premium price for
that. Differentiation strategy is used in this situation and company
positions itself more on branding, advertising, design, quality and new
product development (like Apple Inc. or even Starbucks) rather than
efficiency, outsourcing or process innovation. Customers are willing to
pay higher price only for unique features and the best quality.

The cost leadership and differentiation strategies are not the

only strategies used to gain competitive advantage. Innovation strategy
is used to develop new or better products, processes or business models
that grant competitive edge over competitors.

Sustainable Competitive Advantages

Sustainable competitive advantages are company assets, attributes, or
abilities that are difficult to duplicate or exceed; and provide a superior
or favorable long term position over competitors.
Types and Examples of Sustainable Competitive Advantages
Low Cost Provider/ Low pricing
Economies of scale and efficient operations can help a company keep
competition out by being the low cost provider. Being the low cost
provider can be a significant barrier to entry. In addition, low pricing
done consistently can build brand loyalty be a huge competitive
advantage (i.e. Wal-Mart).
Market or Pricing Power
A company that has the ability to increase prices without losing market
share is said to have pricing power. Companies that have pricing power
are usually taking advantage of high barriers to entry or have earned the
dominant position in their market.
Powerful Brands
It takes a large investment in time and money to build a brand. It takes
very little to destroy it. A good brand is invaluable because it causes
customers to prefer the brand over competitors. Being the market leader
and having a great corporate reputation can be part of a powerful brand
and a competitive advantage (i.e. Coca-Cola (KO).
Strategic assets
Patents, trademarks, copy rights, domain names, and long term contracts
would be examples of strategic assets that provide sustainable
competitive advantages. Companies with excellent research and
development might have valuable strategic assets (i.e. International
Business Machines (IBM).
Barriers To Entry
Cost advantages of an existing company over a new company is the
most common barrier to entry. High investment costs (i.e. AT&T (T))
and government regulations are common impediments to companies
trying to enter new markets. High barriers to entry sometimes create
monopolies or near monopolies (i.e. utility companies).
Adapting Product Line
A product that never changes is ripe for competition. A product line that
can evolve allows for improved or complementary follow up products
that keeps customers coming back for the “new” and improved version
(i.e. Apple iPhone) and possibly some accessories to go with it.
Product Differentiation
A unique product or service builds customer loyalty and is less likely to
lose market share to a competitor than an advantage based on cost. The
quality, number of models, flexibility in ordering (i.e. custom orders),
and customer service are all aspects that can positively differentiate a
product or service.
Strong Balance Sheet / Cash
Companies with low debt and/or lots of cash have the flexibility to make
opportune investments and never have a problem with access to working
capital, liquidity, or solvency (i.e. Johnson & Johnson (JNJ).The balance
sheet is the foundation of the company.
Outstanding Management / People
There is always the intangible of outstanding management. This is hard
to quantify, but there are winners and losers. Winners seem to make the
right decisions at the right time. Winners somehow motivate and get the
most out of their employees, particularly when facing challenges.
Management that has been successful for a number of years is a
competitive advantage.

THE FUNDAMENTALS OF STRATEGY

FORMULATION
Strategic Management is a very broad discipline, its scope spanning the
entire strategic decision-making structure of the organization, from the
management processes and decisions to the activities performed in all its
functional units. The primary focus of this discipline is the conduct of
the strategic management process, which pretty much covers all the
activities and functions performed to enable the organization to cope
well with change over the long term.

The systematic nature of the strategic management process is apparent in

how it was split into three stages: Strategy Formulation, Strategy
Implementation, and Strategy Evaluation and Control.

In this discussion, we will take an in-depth look at the first stage –

Strategy Formulation – and the six steps that you should follow in order
to come up with management strategies that will propel your
organization forward, far ahead of your competitors and rivals.

Strategy formulation is the process of determining and establishing the

goals, mission and objectives of an organization, and identifying the
appropriate and best courses or plans of action among all available
alternative strategies to achieve them.

Always, there is an end in sight, and that is the organizational goals of

the firm. The organization anticipates specific results, which they can
only achieve by following a specific route, or acting within the confines
or parameters of a specific framework. That route or framework will be
created through strategy formulation.

The main reason that the strategy formulation is also referred to at times
as “strategic planning” is because they basically follow the same
concept. Through strategic planning, management is able to evaluate its
 resources and determine the best ways to maximize the
company’s return on investment (ROI). The output – the strategic plan –
will serve as the framework or guide for the members of the organization
in carrying out their respective roles.

Therefore, it is important to note that, although the two phrases are

sometimes used interchangeably, and although they are similar in a lot of
ways, they are not exactly the same.

Aspects of Strategy Formulation

Strategy formulation has three levels or aspects, with the resulting

recommendations in each level being consistent in order to ensure the
formulation of strategies that are cohesive, realistic and viable.

Corporate Level Strategy

In this level, the perspective is broad and wide, so the focus is on the
overall scope, direction and goals of the entire organization. Since we
are looking at the big picture, our concern is the total structure of the
business.

This aspect of strategy formulation has the following components:

●​ Growth strategy: This component is concerned with the direction that

the business is taking. What are the organization’s growth objectives?
 How is its overall performance, and does it coincide with what the
business had in mind when it developed its growth objectives? Are the
growth strategies still consistent with the growth objectives and, if not,
what changes or modifications must be made?

●​ Portfolio strategy: This aspect is all about taking stock of the

organization’s operational structure. What are the lines of business in the
organization’s portfolio? How are these lines interconnected or how do
they fit together? The most common strategies developed at this level
address queries on whether a business should diversify its portfolio or
keep them as they are, and focusing on their concentrations or weights
instead.

●​ Parenting strategy: The main point of concern here is the allocation of

resources and capabilities across the lines of business of the
organization. How will the items in the portfolio be managed? Which
lines require more direct management and control? Which lines are in
need of additional resources to boost their performance?

Business Level Strategy

Large companies usually have multiple lines of business in their

portfolio. The larger firms even distinguish them as separate strategic
business units (SBUs) under a single organizational umbrella. As
strategic business units, they are operational as stand-alone businesses,
which means that competition is bound to arise.

In this level, strategy formulation is geared towards coming up with

competitive strategies between and among the lines of businesses or
SBUs of the organization.

Functional Level Strategy

Compared to the other two levels, the functional level has a shorter
outlook. Within each line of business or SBU, there are functional units
with their own specific tasks and sets of activities. Strategies at this level
are required, primarily addressing how these activities and tasks will be
carried out effectively and efficiently.

Diversification

Diversification strategies are used to extend the company’s product

lines and operate in several different markets. The general strategies
include concentric, horizontal and conglomerate diversification.

Each strategy focuses on a specific method of diversification. The

concentric strategy is used when a firm wants to increase its products
portfolio to include like products produced within the same company,
the horizontal strategy is used when the company wants to produce new
products in a similar market, and the conglomerate diversification
strategy is used when a company starts operating in two or more
unrelated industries.

Diversification strategies help to increase flexibility and maintain profit

during sluggish economic periods.

Warren Buffet on Diversification

“Diversification is protection against ignorance, it makes little sense

for those who know what they’re doing.”

Concentric Diversification

A concentric diversification strategy lets a firm to add similar products

to an already established business. For example, when a computer
company producing personal computers using towers starts to produce
laptops, it uses concentric strategies. The technical knowledge for new
venture comes from its current field of skilled employees.

Concentric diversification strategies are rampant in the food production

industry. For example, a ketchup manufacturer starts producing salsa,
using its current production facilities.

Horizontal Diversification

Horizontal diversification allows a firm to start exploring other zones in

terms of product manufacturing. Companies depend on current market
share of loyal customers in this strategy. When a television
manufacturer starts producing refrigerators, freezers and washers or
dryers, it uses horizontal diversification.

A downside is the company’s dependence on one group of consumers.

The company has to leverage on the brand loyalty associated with
current products. This is dangerous since new products may not garner
the same favor as the company’s other products.

Conglomerate Diversification

In conglomerate diversification strategies, companies will look to enter

a previously untapped market. This is often done using mergers and
acquisitions.

Moving into a new industry is highly dangerous, due to unfamiliarity

with the new industry. Brand loyalty may also be reduced when quality
is not managed. However, this strategy offers increasing flexibility in
reaching new economic markets.

For example, a company into automotive repair parts may enter the toy
production industry. Each company allows for a broader base of
customers. There is an opportunity of income when one industry's sales
falter.